On March 22, U.S President Donald Trump announced tariffs on US$60 billion worth of Chinese goods coming into the U.S. The Office of the U.S. Trade Representative had just days before concluded an investigation into China’s trade practices that supported the measure.

Since then, trade tensions have ramped up. The U.S. and China have implemented tit-for-tat tariffs on US$50 billion of exports from each side, and are on the brink of slapping tariffs on hundreds of billions more worth of exports.

Investors have been worried about the potential fallout of a trade war on the economies of China, the U.S., and everything in between. We’ve written previously about what the consequences of the trade war could be (see here, here and here).

Now, after six months, the impact on global markets is clear. And we have a better idea about the future impact…

China is “losing” and the U.S. is “winning”

The impact of the trade war on China’s economy, thus far, seems minimal – and, oddly, looks to be the opposite of what you might expect.

Chinese exports continued to grow nearly 10 percent year-to-year in August, down slightly from 12.2 percent growth in July. And China’s trade surplus (the excess of its total exports over its total imports) with the U.S. hit a new record of US$31 billion in August.

So in the short term, Trump’s tariffs are having the exact opposite effect on trade. China is exporting more to the U.S. – not less.

Now, one possible explanation is that U.S. buyers may be stockpiling Chinese imports ahead of additional anticipated tariffs.

Chinese exports to the U.S. were also likely bolstered by the 8 percent devaluation in the Chinese yuan since March 22, which significantly offset the impact of tariffs already in place… and further cheapened those products not yet taxed by the Office of the U.S. Trade Representative.

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But stock markets anticipate – they reflect expectations, rather than the present. And markets appear to be anticipating a slowdown in the earnings of Asia’s companies – as reflected in the 8.2 percent decline in the MSCI Asia ex-Japan Index since March 22. China’s Shanghai Composite Index has also dropped 20.3 percent. By comparison, the S&P 500 has gained 10.5 percent over the same period.

By this measure, China is losing, the U.S. is winning. China has a lot more to lose in this trade war than the U.S., because China exports goods worth US$530 billion a year to the U.S. On the other hand, it imports just US$187 billion of U.S. goods annually. So China’s scope to retaliate is limited.

So how are other Asian markets doing?

As shown in the graph above, other markets that have been the region’s worst-performers since the trade war began include Vietnam (down 17.8 percent), Singapore (down 9.5 percent) and Hong Kong (down 7.6 percent). All of these countries have economies that are significantly tethered to China’s performance, so a potential Chinese slowdown could be detrimental to their economies.

The strong performers in Asia since the trade war have been India and Australia. India, in particular, has seen its economy strengthen on the back of economic reforms and soaring domestic consumption, with GDP growth hitting a blistering 8.2 percent in the first quarter of the 2019 fiscal year.

But it’s important to note that the trade war is also one dynamic of the stock market. As I said earlier, the stock market reflects expectations of corporate earnings, the local economy, interest rates, exchange rates and a broad range of other markets. The evolving trade war is an important input, but only one of many.

How Asian stock market sectors have performed

So what specific Asian sectors are being hit the hardest – or benefitting from the trade war?

As the graph below shows, the energy and utilities sectors of the MSCI Asia ex-Japan index have outperformed, rising 5.4 percent and 0.9 percent, respectively. The telecommunications sector has declined just a modest 0.9 percent.

But as you can see, sectors heavily dependent on the global trade and supply chain performed the worst. These include the consumer discretionary (i.e., leisure products and automobiles), information technology and industrials sectors.

President Trump now says he wants to slap tariffs on Chinese exports that have not yet been affected by the trade war (estimated at US$267 billion) as soon as possible. So the same markets and sectors that have done well over the last six months will likely continue to outperform well. And the sectors that have done poorly will likely continue to underperform.

So in this deteriorating trade environment, you want to have more exposure to Australian and Indian stocks. And based on recent performance, the energy, utilities and telecommunications sectors will likely continue to outperform.

In the deluge of wall-to-wall media coverage of U.S. President Donald Trump and North Korean Supreme Leader Kim Jong-Un, no detail is too small to sift through. Will Kim Jong-Un bring his own toilet so that no one can purloin his poop? Will the two swap hair care tips during summit lulls? Was Trump really concerned about Canadian Prime Minister Justin Trudeau “pouring collateral damage” on the summit?

(I’ll tell you more about this tomorrow. This morning, I’m going to join the ranks of the media. I’ve been quoted in the media… I’ve written commentary in the media… and I’ve been written about in the media, but I’ve never been a card-carrying member of the media myself. Until today.)

Singapore – where I live – is aflutter with activity at being the venue of the summit. And since the country is small, it’s difficult not to be affected by the summit one way or another. Based on what the international media writes about it, you’d be forgiven for thinking that Singapore’s official name is “Tiny Singapore”. If it were 11 times bigger, it would be as large as the metropolitan area of the city of Columbus, Ohio, in the U.S.

Singapore views the summit as an “opportunity to show off… as an advanced and attractive city state that effortlessly blends hi-tech and high finance with tropical beauty,” according to a local marketing industry web site. It’s even footing the estimated US$15 million bill for the event, including the cost of putting up the North Korean delegation.

What Trump and Kim won’t need to worry about

Singapore has been good at staying friends with pretty much everyone (if you’re the little kid on the block, you can’t afford to be enemies with anyone), and it’s geographically close to North Korea (there were questions about how far Kim Jong-Un’s plane could travel). And no place is more organised and efficient than Singapore. If you need something done that’s tricky, complicated and full of logistical nightmares, give it to the Singaporean government to figure out. (In Singapore, people aspire to work for the government… it’s a prestigious, well-compensated and rewarding career path. How strange is that?)

So there are also a lot of things that Trump and Kim don’t need to worry about in Singapore…

Protests. If the government here says there will be no protests, there will be no protests. That’s how things work in Singapore. If the light is red for pedestrians, you don’t cross, regardless of whether there’s a vehicle in sight. And if you don’t like the way the system operates in Singapore, don’t let the door hit you on your way out.

Drugs. The death penalty is – not surprisingly – a good deterrent.

Cold weather. The weather is exactly the same on June 12 as it is on October 12 or February 12 – that is, humid and hot. If you like seasons and cold weather, that’s a problem. If you like heat and predictability (and wearing shorts year-round), it is not.

Air conditioning. If you need to escape the heat, you can head into any nearby shopping centres to cool off.

Long travel times. In much of the U.S., people drive 45 minutes to get a good deal on milk or to take their kids to soccer practice. In Singapore, 45 minutes takes you clear across the country.

Traffic. Motorcades for visiting heads of state don’t have to worry about traffic in even the most sclerotic cities. But here, normal people (the 15 percent or so of the population that owns a car, at least) don’t have to worry about traffic, either. In Singapore, people complain (“there was a jam!”) if they have to wait for more than a single red-green-yellow cycle stoplight. (Putting a car on the road here costs three or four times more than it does in most of the rest of the world – so there are fewer cars.)

Potholes. Not having cold weather is good for blacktop. But in any case, in the hyper-organised (and proud) world of Singapore, a pothole would be a minor disgrace.

Wi-Fi connectivity. Almost every part of Singapore has reliable and complimentary Wi-Fi connectivity, even on trains and at bus stations.

Singapore’s market (by the way) is cheap

On another front entirely… Singapore’s stock market is one of the world’s cheapest, based on the cyclically adjusted price-to-earnings ratio (CAPE) (which we’ve written about here). As shown below, the market trades at a CAPE of 14.4, compared to 30.6 for the U.S., and 18.1 for Hong Kong, for example. (We wrote about this a while ago… since then, Singapore’s market is up 26 percent.)

My colleague Kim Iskyan has been warning of the potential for a trade war between the U.S. and China for 18 months now (you can read his previous alerts here and here… and subscribers to The Churchouse Letter will know that his investment recommendation to take advantage of this escalating mercantilist skirmish is up nearly 100 percent. But this is only the beginning… learn more here.)

Over the past couple of weeks, the trade war cries out of the White House have substantially intensified. Firstly, Trump finally made good on his promises about implementing drastic protectionist measures, with tariffs on U.S. steel imports and aluminium imports of between 10 and 20 percent.

His top economic advisor, Gary Cohn, a well-respected and more centrist pro-trade force within the administration duly resigned and took his turn walking through the entrance to the White House which has seemingly been replaced by revolving doors.

Without getting into a debate about the wisdom of protectionist tariffs (not that it would be a particularly long one), the reality is that these initial measures don’t really affect China all that much. Some 14 percent of China’s aluminium exports currently head to the U.S., and less than 3 percent of its steel goes there.

At the end of the day this hits the EU, Japan and Canada (41 percent of U.S. aluminium imports for example) far more than China. The total amount of steel and aluminium imported into the U.S. is minimal anyway. And the corresponding increases in cost will simply fall on U.S. companies and consumers.

But what’s more important is the signal that the implementations of these tariffs communicate. And as more nationalist and protectionist elements within the White House, like Peter Navarro, the key architect of Trump’s “America First” campaign and Commerce Secretary Wilbur Ross, we should be prepared to expect further escalation of these types of trade measures, and without doubt China is in the cross hairs.

[To get a sense of where Navarro is coming from, you can watch this full-length feature documentary here based on his book… the unambiguously titled “Death by China: Confronting the Dragon – A Global Call to Action”]

Earlier this week, U.S. President Donald Trump put issued an ultimatum to China… reduce the trade deficit (i.e. the difference between the amount of goods and services that America imports from China versus the amount it exports to China) by US$100 billion. Note, the current trade deficit runs at approximately $375 billion.

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Or else… Chinese import tariffs of up to US$60 billion on I.T., telecoms and consumer products – themselves all part of a U.S. examination of Chinese intellectual property violations – will likely be implemented.

Trump has a point

All foreign businesses, including U.S. ones, that operate or at least try to in China will likely tell you the same thing: it’s extremely frustrating, and they have to give up a lot for questionable gain.

The price for foreigners operating in China is often handing over their technology to local “partners” in return for access to the market, effectively fuelling your future competition with your hard-earned intellectual property.

And we’ve seen anecdotal evidence of industries where the Chinese government will implement laws that are impossible to adhere to in practice (i.e. unfeasibly low pollution emissions for production of a particular chemical for example), and simply apply that law to foreign businesses operating domestically and somehow conveniently overlooking local companies.

That’s before we get to the endless amounts of government support provided to industry state champions, rendering them impractical to compete with.

But China is simply too big for companies to ignore. And therein lies the problem for Trump. In an American Chamber of Commerce survey, a quarter of respondent companies stated that China provides at least 25 percent of their global revenues. Over 50 percent place China as one of their top three global investment objectives.

When a tech-savvy billion-strong population’s economy is growing by 6-7 percent annually, it’s hard to look the other way.

Unless a full-scale trade war breaks out, it’s unlikely that we’ll see much damage to financial markets. The bigger hit to U.S. equities for example came from Cohn’s resignation, not the announcements of tariffs.

In other words, be prepared for a lot more “noise” over the coming weeks and months ahead, but we are a long way away from this being any kind of pretext to lighten up China equity positions.

Good investing,Tama

P.S. Rather than lightening any positions in China… it’s time to double down on an asset that could rally sharply as things continue to heat up. Learn more here.

Right up until his death in 2016, Cheng Yu-tung was a true lion of Asian business…

Typical of many Chinese billionaires, his success came from humble beginnings. He started in the jewellery business in Macau in the late 1930s. He later inherited and grew the family business.

From there he moved, like so many of his generation, into property in Hong Kong, in the 1960s.

Forget diamonds and gold… real estate is where real money was made.

Cheng Yu-tung was a highly regarded businessman who extended his reach beyond property and jewellery into infrastructure, retail and hotels.

His core company was New World Development (Exchange: Hong Kong; ticker: 17). His jewellery company was Chow Tai Fook (Exchange: Hong Kong; ticker: 1929) for more than 30 years.

In my investment banking days, I was part of the team that took New World’s China property business public. It was one of the earlier China property sector IPOs.

New World was a pioneer, showing how foreign companies could take on China’s fledgling property markets in a big way.

Asian property investors and developers have often struggled when entering foreign markets, but one example of a “win” involved the Cheng family and a fellow Hong Kong tycoon, Vincent Lo, another property tycoon with big real estate interests in Hong Kong and China… and, as it would happen, an American developer named Donald Trump.

The Yards deal

This particular deal initially dates back to the 1970s. But it really took shape in the mid-1980s. It involved the Manhattan West Side Yards, a 77-acre site on Manhattan’s west side.

The owners went into bankruptcy and the site fell into the hands of banks. Trump’s role in this began in 1985, when he acquired the Yards from another distressed developer for US$115 million.

Given Trump’s frequent incursions into bankruptcy and financial distress, it’s not surprising that it didn’t take long for this asset would fall into the “distressed” bucket again.

In the early 1990s, the site, under Trump’s control, was bleeding cash. The New York property market was undergoing a correction at the time, which didn’t help.

Trump’s bankers forced him to relinquish control of the site.

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The new owners? The Cheng family and Vincent Lo.

In 1994 they paid US$82 million, and assumed the roughly US$250 million debt that Trump had accumulated.

The new owners set about developing the site with up-market condos and other uses. Trump was entitled to a share of the profits from property sales, and took management and construction fees during the build.

In 2005, the Hong Kong team agreed to sell the development for around US$1.76 billion.

And that’s when Trump screamed blue murder.

How the Cheng family and Vincent Lo beat Trump

The case ended up in the courts.

Trump tried to sue the pants off the Hong Kong partners. His argument? They should never have sold it for that price. It was worth much more, he contended.

He refused to accept his share of the proceeds of the sale.

Over the next four years, the case dragged on, producing 166,000 pages of documents for the court.

Trump accused his Hong Kong “partners” of all sorts of infringements… from tax evasion to fraud.

He lost.

His compensation was a minority interest in the New York and San Francisco Bank of America Buildings (which were recently worth around US$640 million, according to Bloomberg).

Trump of course has since said that this was a great deal… and that he won! One of those times he “beat China”…

One lesson? This illuminates the character of the U.S. president, for one thing. More broadly, though, this story demonstrates the importance of retaining control over investments where possible.

Trump was a minority shareholder in the project and couldn’t drive it as he wanted. Despite having his name on the buildings, he was a passenger.

Today, we’re showing you another indicator that shows we could be in for a below-average year: the U.S. election cycle.

Politics and performance

The economic cycle and market valuations generally play a bigger role than presidential politics in the movements of U.S. markets. But in the past, American presidential elections still have a significant impact on the U.S. stock market. The cycle of anticipated policy changes, economic stimulus, the fantasy that real positive change might happen, and, of course, disgust and despair at politics as usual, all figure into markets.

As we’ve shown you before, U.S. markets have historically done well in a post-U.S. election year, which was 2017. This has little to do with the identity of the person who happens to be sitting in the American White House.

Since 1928, the S&P 500 has risen, on average, by 5.1 percent in a post-election year. In 2017, the S&P 500 rose around 20 percent.

In pre-election years (which we define as the calendar year that’s before the year in which a presidential election takes place), the S&P 500 has risen on average by 12.8 percent.

But, on average, the S&P 500 has seen the worst performance in the second year of a U.S. president’s four-year term (which is 2018 for this cycle).

This cycle holds true in Asia, too.

The U.S. election cycle and Asia’s stock markets

Surprisingly, Asia’s stock markets have been more affected by the American presidential election cycle – especially when a Republican is in power – than the U.S.’s own stock markets. (An important caveat, as I’ll explain below: There isn’t that much history for this, as Asia’s stock markets are a lot younger than those of the U.S.)

In the past, when a candidate from the Republican party of the U.S. has become the country’s president, Asia’s markets (measured by the MSCI ex Japan Index) overall have performed well during the first year of the new president’s term, rising just over 19 percent on average. In 2017 (the first year of a new Republican party president) the MSCI ex Japan rose nearly twice that, 34 percent.

And like in the U.S., things take off in the third year (which will be 2019) of a Republican president’s four-year term. During this year, the MSCI Asia ex Japan Index has seen average returns of nearly 36 percent. Hong Kong’s stock market has risen nearly 33 percent, Singapore and Malaysia have seen average returns of 31 percent and 24 percent, respectively.

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But during the president’s second year (which will be 2018), there’s a slump. The MSCI Asia ex Japan Index has seen average returns of 3.4 percent. Hong Kong’s stock market has risen only 3.6 percent and Malaysia has seen average returns of -2.3 percent. Only Singapore wins in the second year, rising 11.7 percent.

For our purposes in the graph above, we break the election cycle down into four periods:

1. Post-election year: The first calendar year after the U.S. presidential election. That was last year – 2017.

2. Midterm: The second year. This is 2018 in the current cycle.

3. Pre-election: The third year of the president’s term, which is also the year before the next election. This will be 2019 in the current cycle.

4. Election year: The fourth year of the president’s term, and the year in which elections are held. 2016 marked the election year in the previous cycle, and 2020 will be the current cycle’s election year.

However, the sample size for the Asian market results is small. The indexes that we’re using – and Asia’s stock markets – haven’t been around for many four-year American presidential cycles. And broken down by the two major U.S. political parties, the sample size is even smaller.

For instance, the MSCI Asia ex Japan Index has only seen seven U.S. presidential election cycles, covering three Republican presidents and four Democratic presidents. The small number of data points means that historically unusual periods (like big stock market losses during the global economic crisis in 2008, or particularly strong years for the stock market) have a very big impact on average returns.

Why would American politics affect Asia’s stock markets?

Only rarely does American foreign policy towards Asia have a direct impact on stock market performance in Asia. Far more important is the role of American politics on U.S. market movements, and on global stock market sentiment – and therefore also on Asian markets. This may play out in a more important way in smaller, less liquid markets in Asia (where a smaller absolute sum of funds invested or withdrawn can have a far greater impact than in bigger markets). So positive or negative sentiment in the U.S. with respect to American policy, and presidents, might impact smaller Asian markets more than others.

Twitter-happy U.S. President Donal Trump could also impact Asian markets more than usual – and markets could deviate from the election cycle norm. In light of Trump’s unorthodox policies and positions, stock market performance patterns may be completely different over the next three years from the past. And recent changes to the tax code in the U.S. may have a positive impact on markets.

But if the U.S. election market performance cycle remains intact – as it has so far – it’s looking like 2018 could be weak for most Asian markets.

How solid is the current economic recovery? In late April I argued that the recovery was faltering and that cracks were starting to appear in the “Trump rally” in US equities.

I wrote then that a stock market can rally on promises – in the case of the Trump presidency, promises of lower regulation, tax cuts, and infrastructure spending. But it takes concrete results to sustain it, and those results aren’t being delivered.

US equity markets have continued to grind upwards. The S&P500 is up another 2.1 percent since I raised the idea that the Trump rally was sitting on a shaky macroeconomic foundation in late April. And it’s up 8.5 percent in 2017 so far.

The CBOE S&P 500 Volatility index (or VIX), which measures the expected level of equity market volatility has fallen back below 10. This means investors are not bracing for a sharp decline in US equity markets any time soon.

Meanwhile, US economic data continues to be weak.

Last weeks’ US nonfarm payrolls (NFP) data were not encouraging. NFP data provides month-on-month changes in US employment. It’s a key barometer for overall economic health. In May data showed that 138,000 jobs added that month versus expectations of 182,000. That’s a 25 percent miss.

Cracks show in the bond market first

More interesting is what’s going on in the US treasury market.

In the aftermath of Donald Trump’s electoral victory in November, 10-year treasury yields shot up from less than 1.8 percent to 2.6 percent in the space of a month.

When bonds prices fall, yields rise.

This was all part of the “Trump rally” in equity markets. The view was that a Trump presidency would lead to faster growth, higher inflation – and therefore faster interest rate rises. (If the economy grows faster, the U.S. Federal Reserve would likely boost interest rates faster .

As a result, the market sold US treasuries (which perform poorly in a rising interest rate environment). (For bonds, a higher yield equates to a lower price.)

The chart below shows the Commitments of Traders (COT) report on net US treasury futures positions in 2016, up to the end of February 2017. Treasury futures are contracts to buy or sell US treasuries for a specific price at some point in the future. They are extremely liquid instruments used by traders and asset managers to hedge or bet on US treasuries.

This COT data is published weekly and shows to what extent the market is long or short (i.e. betting against) the price of the 10-year US treasuries.

A positive number means the market is generally long US treasury futures contracts, which means traders think bond prices will rise (and hence yields will fall).

A negative number implies the market is betting against treasuries and expects the price to fall (and hence yields to rise).

As soon as Trump was elected, the net futures COT numbers went negative. That is to say, the market began betting heavily against US Treasuries.

The market was anticipating that the price of Treasuries would fall. And it did. Treasury yields increased and bond prices fell.

The graph above shows data from January 2016 up to the end of February this year.

You can see in November 2016, when Trump won the election, that 10-year yields rose quickly, and the net COT postion went negative i.e. traders began betting heavily against the US treasury market.

But take a look at the next chart below. This shows you the COT numbers up the end of May, and in the context of the past decade.

You can see that in recent months traders have suddenly switched from betting heavily against treasuries, to betting heavily on treasuries. It’s the largest and fastest swing ever recorded (in data going back to 1993) in such a short time period.

The reality is, if the US economy is in such good shape, and interest rates are likely to rise as a result, then the market wouldn’t be betting so heavily on treasuries all of a sudden. If the bond market is boss, then right now it’s saying you better look out… the Trump rally and economic recovery aren’t a ‘given’. Traders are now positioned more bullishly on the US treasury market (i.e. betting bond prices will rise and yields will fall) than any time since 2007.

Let me be clear: if the market was optimistic on the US economic outlook, you simply would not see so many people betting on the US treasury prices rising.

Look east

Because of US economic frailties, I suggested earlier that investors look at shifting some of their US equity exposure to Chinese equity markets. I cited a relatively strong economic foundation and stabilisation in the renminbi, the Chinese currency.

Specifically I said “We are bullish on H-Shares.” (H shares are Chinese companies listed in Hong Kong.)

It’s early days, but since then H shares have outperformed the S&P500, with A shares (Chinese companies listed in China) not far behind.

We’re still bullish Chinese equity markets. And in our most recent edition of The Churchouse Letter, Peter makes his case why…

Common sense would suggest that political uncertainty should weigh on a country’s stock market.

If investors can’t determine with a reasonable degree of certainty which policies will be enacted and when – such as whether taxes will be cut or not – it stands to reason that stocks should be less attractive.

Back in January, I wrote that the U.S. was about to become the world’s largest emerging market. I said:

Political risk expert (and a former boss of mine at Eurasia Group, a political risk analysis consulting company) Ian Bremmer defines emerging markets as “those countries where politics matters at least as much as economics for market outcomes”. This suggests that the usual suspects that investors look at for signs of market trajectory – economic growth, inflation, interest rates, for starters – are downgraded to only be as important as politics. And in some cases, individual leaders can change institutions, further swaying markets.

According to this definition, the U.S. is taking on some of the characteristics of emerging markets – that is, where political risk matters more.

U.S. President Donald Trump moves markets with politically motivated comments about companies, industries and countries in a way that’s far more common in emerging markets than – historically at least – developed markets. He talks about the NAFTA trade deal and the Mexican peso gyrates. A seemingly offhand remark about a company can send its market value down by hundreds of millions of dollars.

Earlier in the year, I suggested that if U.S. markets were to act more like emerging markets, they could be in for a fall. That’s because emerging markets historically trade at lower valuations (like the price-to-earnings ratio) than developed markets. So in order to adjust to a lower (closer to emerging market levels, that is) P/E ratio, either earnings would have to fall, or prices – of shares, that is, overall – would have to fall.

Does political uncertainty matter for U.S. markets?

That hasn’t happened (yet, at least). This is partly because the broad policy outlines sketched by President Trump – few of which have come to fruition yet – are seen as pro-growth and market friendly. Infrastructure investment, tax cuts, and taking an axe to regulation perceived as anti-business are all ingredients for a bubbly stock market, at least in the short term.

So far, this has outweighed the greater political uncertainty of President Trump. The S&P 500 has risen a bit more than 6 percent since the U.S. election in November. It’s up almost 7 percent in 2017 so far.

The U.S. market isn’t the only one where uncertain and volatile domestic politics are not hurting (and perhaps even helping) stock market returns.

For example…

South Korea is up

South Korea has a nightmare neighbour to its North. Though a war of anything other than words is unlikely, you might think that investors in South Korea’s stock market might sell just in case. What’s more, the country’s president was recently impeached and ousted, and citizens go to the polls for presidential elections on May 9.

Meanwhile… South Korea’s Kospi Index recently hit six-year highs. It’s up 17 percent in U.S. dollar terms in 2017 so far. The won, Korea’s currency, is up almost 7 percent against the U.S. dollar.

So is Turkey

Turkey’s president Recep Tayyip Erdogan recently won a referendum that grants his office significantly expanded powers. Even before the polarising referendum, Turkey was headed in a dangerous direction, by western democratic standards. “Erdogan’s thirst for one-man rule threatens Turkey,” warned a mid-March opinion piece in the Financial Times.

A few days ago the government moved to restrict television dating shows and it blocked access to Wikipedia, as part of a crackdown on the media and internet. By western liberal standards, Turkey is going to the dark side.

So how is the Turkish stock market doing? It’s up 21 percent in U.S. dollar terms in 2017 so far. The country’s currency is roughly flat.

What does it mean?

Trump’s market-friendly policy announcements – even if they’re getting bogged down in execution – are moving markets more than the president’s muddled delivery and his trigger-happy Twitter fingers. The anticipation of a strong economy can mean a lot more than political uncertainty.

Also, what bothers journalists doesn’t necessarily bother investors. The president of the Philippines – like his colleague in Turkey – has become a poster child for stomping on human rights. But the country’s stock market is up 12 percent this year.

And don’t forget… it’s all about your time frame. How markets view a policy or a politician changes over time. Today’s contrarian view is tomorrow’s consensus view. Measures or words that bolster markets now may be a slow-burn fuse that blows them up months later.

Until not long ago, U.S. President Donald Trump was intent on waging a currency war with China. Now… he’s not.

What changed? Let me explain.

“I will direct my secretary of the treasury to label China a currency manipulator. China is a currency manipulator. What they have done to us by playing currency is very sad.”
Donald Trump, October 22, 2016

A month or so ago I killed a couple of hours on a rainy Sunday afternoon by taking my kids to see the new Batman Lego movie. As the movie finished, while the kids were rummaging around under their seats for misplaced/dropped shoes and water bottles, a familiar name in the closing film credits caught my eye – Executive Producer, Steven Mnuchin.

It’s not a common name, so I did a quick check on my phone – yes, this was the Steve Mnuchin, long-time friend of Donald Trump and the same Steve Mnuchin who, when he’s not producing movies about plastic objects coming to life to save the world, has a day job as U.S. Secretary of the Treasury.

I had exactly the same reaction this past Sunday morning over breakfast as I read through a recent report from Mnuchin’s Treasury Department.

The report was a summary of Foreign Exchange Policies of major U.S. trading partners. It’s a regular brief to Congress (the U.S. national legislative body) which reviews exchange rate policies from global U.S. trading partners. It provides an update on which countries are engaged in unfair practices or are outright manipulating their currencies.

The Treasury monitors three specific criteria that a trading partner must trigger to potentially incur further enforcement i.e. being “labelled” a currency manipulator.

Running a material current account surplus being at least 3 percent of GDP. A current account surplus exists in countries that save more than they invest, and are a net lender to the rest of the world. Typically, these countries are large manufacturing exporters or energy exporters.

If these three criteria are triggered by China, then the Treasury is mandated to spend a year trying to resolve the issue through negotiations with Chinese counterparts. And if those steps fail then there can be retaliatory measures such as stopping U.S. government development agencies from financing programs in China – although these have already been halted for years anyway after the 1989 Tiananmen square crackdown.

The “labelling” of China as a manipulator is more of a risk factor in its ability to further weaken Sino-U.S. relations through uncertainty – we don’t know how China would react. What would a war with China and its currency, the renminbi, look like?

What we do know, or at least what we thought we knew, was Donald Trump’s view on the matter. He has consistently attacked China’s “devastating currency manipulation”.

Trump realizes a currency war with China is not a good idea

This is why Steve Mnuchin’s Treasury Report is so interesting. So what did the Lego movie master decide?

To save you the suspense, the Treasury Department gets straight to the point (on the first page in fact) and states the following:

Treasury has found in this Report that no major trading partner met all three criteria for the current reporting period. Similarly, based on the analysis in this Report, Treasury also concludes that no major trading partner of the United States met the standards identified in Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (the “1988 Act”) for currency manipulation in the second half of 2016.

So to be clear, Donald Trump’s Treasury Department has confirmed what we’ve been saying all along (below is an excerpt from January’s edition of The Churchouse Letter)

“It’s pretty hard to argue that China is guilty of anything here…

Pressure on the renminbi is not being engineered by the central bank. It is a by-product of an increasingly open Chinese capital account and the desire for individuals and companies to invest (or simply take money) offshore.

There is genuine demand for capital outflow which necessitates selling renminbi.

If anything, China is trying to stem capital outflow in a bid to soften the pace of depreciation!

Bear in mind, these capital outflows are both expected and long overdue. We wrote about this particular phenomenon nearly two years ago in ‘A $35 Trillion Dollar Bonanza’.”

But what I found so amusing in this report was the new additional language that Trump’s Treasury has now inserted. I immediately recognised the new text because I’d read the October 2016 report.

I’ve highlighted the significant additions in yellow below.

The first highlighted section complains that although the renminbi did appreciate against the dollar, China didn’t let its currency appreciate fast enough from its initial “deep undervaluation”. As a result (according to this line of argument), this caused significant and long-lasting hardship to American workers and companies. Sadly, however, the report doesn’t reference any supporting evidence of this hypothesis.

The second highlighted section finally acknowledges that China’s “recent intervention in foreign exchange markets has sought to prevent a rapid RMB depreciation that would have negative consequences for the United States…”.

So, according to the Treasury, first China damaged American workers and companies by not letting its currency appreciate fast enough… but now China is not only preventing depreciation, but that depreciation would also have “negative consequences for the United States”.

So now the U.S. is grateful China is intervening in its currency market because if it didn’t, the renminbi would depreciate faster!

It seems clear now why the Chinese haven’t taken this threat of labelling them as a “currency manipulator” terribly seriously.

But the Treasury saves the best ‘till last:

“China will need to demonstrate that its lack of intervention to resist appreciation over the last three years represents a durable policy shift by letting the RMB rise with market forces once appreciation pressures resume.”

Huh?

“Lack of intervention to resist appreciation over the last three years”? There’s been no ‘appreciation’ pressure to resist!

See the chart below of the renminbi against the dollar over the past three years.

Go ahead, try and defuse that logic bomb.

China has spent the past three years fighting depreciation, not appreciation. The renminbi is down 14 percent against the dollar and it would be down a heck of a lot further had the People’s Bank of China (PBOC) not spent a trillion dollars in foreign currency reserves since early 2014 trying to defend it.

So, the first half of that sentence makes no sense.

But Trump’s renminbi capitulation comes in the second half where it says, “letting the RMB rise with market forces once appreciation pressures resume”.

This puts the entire “China currency manipulator” argument on ice for the foreseeable future. The Treasury has effectively just asked China to keep doing what they’re doing (that is, to resist further renminbi weakness), but to let the currency re-appreciate when the times comes. That could be five years away.

It’s hard to know what triggered this dramatic change of course by the Trump administration on the renminbi. The White House simply remarked that “circumstances change”, and Trump himself said, “Why would I call China a currency manipulator when they are working with us on the North Korean problem?”

Regardless of why the White House has completely backtracked on this issue, it does remove a potential negative overhang on Sino-U.S. relations.

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